Formular from the book: FCFE= CFO - FVInv + Net Borrowing As I understand, net borrowing is debt and should be added to FCFF (free cash flow for all investors), not to FCFE (free cash flow for common shareholders only) Why do they add it to FCFE? Please help me to understand this issue Thank you
net borrowing = New debt + Repayment of existing debt FCFE is cash flows available to Equity holders. This is available after the Debt Holders have been paid and additional debt taken has been accounted for. Hence Net Borrowing is added to arrive at the cash flow available.
Net borrowing = new debt - repayment of debt Let’s say I am estimating value of a firm by discounting future FCFE to PV. If the firm’s managers decide to take a lot of new loans, it will substantially increase net borrowing and thereby FCFE and value of the firm. This is what makes me confused. If the managers decide to increase the firm’s debt, it shouldn’t increase its value. Thank you very much!
which is why you would not use FCFE to value a company in the initial phases of its life, when it is likely to take more debt. Also think of the use of debt. It would be used for large scale investments, most like in Fixed Capital. So the FCInv would decrease the FCFE, offset by an increase in Debt. A company would not just be taking debt and not using that debt.
which is why you would not use FCFE to value a company in the initial phases of its life, when it is likely to take more debt. Also think of the use of debt. It would be used for large scale investments, most likely in Fixed Capital. So the FCInv would decrease the FCFE, offset by an increase in Debt. A company would not just be taking debt and not using that debt.
Very clear clarification! Thanks cpk123
Some companies have actually taken on debt explicitly to make dividend payments. Obviously not a sustainable practice longer term…but it does provide a good illustration of how net borrowing can result in cash flows to a stock holder.
FCFE is not the “value” of the firm . Its just a measure of cash flow in a period. And Net borrowings increases the cash flow but only to stock holders , not debt holders